Monday’s Adjudication Roundup

Monday’s Adjudication Roundup

Housing Finance Reform at a Glance

The Urban Institute has posted its November Housing Finance At A Glance.  This is a really valuable resource. The introduction provides a nice overview of recent developments in the area:

With a sweeping midterm election victory for the GOP, the path to legislative GSE reform got considerably narrower. Thus, the focus for reform turns to the FHFA and FHA, where we expect significant movement in the coming months. Over the past six months, the FHFA has asked for input on a variety of issues, and we have commented on them all: guarantee fees and loan level pricing adjustments, Private Mortgage Insurance Eligibility requirements (PMIERs), the single security, and affordable housing goals.
The FHFA has made a concerted effort to open the credit box, strengthening the provision by which lenders are relieved from much of their put-back risk and raising the maximum loan-to-value ratio for some GSE loans from 95 to 97. Both will help expand access without unduly increasing GSE risk. FHFA Director Mel Watt has indicated in recent speeches that work is underway to further clarify reps and warrants, with more guidance on the sunset provision, an independent resolution process for put-back disputes, and remedies short of a put-back for lesser mistakes.
As our new credit availability index indicates, these actions to open the credit box are very important. Our index shows that post-crisis loans have half the credit risk of loans made in the 2000-2003 period. The GSE channel is particularly tight, with about a third of the risk of the 2000-2003 period. This is corroborated by the data in our special feature, which shows that only 8.3 percent of recent Fannie loans (page 34) and 7.4 percent of recent Freddie loans (page 36) have FICOs under 700, compared to 35-37 percent in 1999-2004.
On the FHA side, there have also been initiatives to open the credit box, as outlined in the Blueprint for Access program. Since then, the FHA has released the initial critical draft chapters of their guidebook and a draft of the taxonomy of defects. Many hope to see lower mortgage insurance premiums to broaden access and lessen the risk of adverse selection as better credit flees to the less costly GSEs. Given that their actuary now projects that the FHA’s Mutual Mortgage Insurance Fund will not reach the statutory reserve requirements until 2016, however, such a move is far from certain.
Risk Sharing Developments
The GSEs continue to broaden their risk sharing activities, now turning to front-end risk sharing deals. Prior to this month, they had focused exclusively, and with much success, on laying off risk already on their books, known as back-end risk sharing. Fannie has laid off risk on 7.5 percent of their book of business and Freddie on 11.9 percent of theirs (page 21), both far exceeding the requirements of the Conservatorship Scorecard. The GSEs started including mortgages over 80 LTV in these transactions in May.
This month saw a very meaningful step in bringing private capital back into the mortgage market: the first front-end risk sharing deal, JPMorgan’s Madison Avenue Securities 2014-1 (page 21). JP Morgan warehoused loans made by JP Morgan Chase bank, then sold them in bulk into a newly issued Fannie Mae MBS, presumably for a very meaningful reduction in guarantee fees. JP Morgan retained the first 4.75 percent subordinated interest, and a 26.88 bps servicing strip that absorbs losses before the subordinated interest. The risk on the 4.75 percent subordinated interest was sold in the capital markets in the form of credit linked notes. Redwood Trust is also reported to be contemplating a front-end risk sharing transaction.
Front-end risk sharing bears important similarities to the private capital/catastrophic insurance structure contemplated by many GSE reform proposals. It is thus an administrative opportunity to experiment deliberately with a truly reduced government footprint in the conventional mortgage market. (3)
I am very excited by the possibility of putting private capital in a first loss position for residential mortgages and agree with UI that the stars are aligning, at least a little bit, for this to become a reality. Many interests will need to be balanced for this to move forward, but politicians of all stripes should be worried about leaving Fannie and Freddie in limbo for much longer.

Is Freddie the “Government” When It’s In Conservatorship?

Professor Dale Whitman posted a commentary on Federal Home Loan Mortgage Corp. v. Kelley, 2014 WL 4232687, Michigan Court of Appeals (No. 315082, rev. op., Aug. 26, 2014)  on the Dirt listserv:

This is a residential mortgage foreclosure case. The original foreclosure by CMI (CitiMortgage, apparently Freddie Mac’s servicer) was by “advertisement” – i.e., pursuant to the Michigan nonjudicial foreclosure statute. Freddie was the successful bidder at the foreclosure sale. In a subsequent action to evict the borrowers, they raised two defenses.

Their first defense was based on the argument that, even though Freddie Mac was concededly a nongovernmental entity prior to it’s being placed into conservatorship in 2008 (see American Bankers Mortgage Corp v. Fed Home Loan Mortgage Corp, 75 F3d 1401, 1406–1409 (9th Cir. 1996)), it had become a federal agency by virtue of the conservatorship with FHFA as conservator. As such, it was required to comply with Due Process in foreclosing, and the borrowers argued that the Michigan nonjudicial foreclosure procedure did not afford due process.

The court rejected this argument, as has every court that has considered it. The test for federal agency status is found in Lebron v. Nat’l Railroad Passenger Corp, 513 U.S. 374, 377; 115 S Ct 961; 130 L.Ed.2d 902 (1995), which involved Amtrak. Amtrak was found to be a governmental body, in part because the control of the government was permanent. The court noted, however, that FHFA’s control of Freddie, while open-ended and continuing, was not intended to be permanent. Hence, Freddie was not a governmental entity and was not required to conform to Due Process standards in foreclosing mortgages. This may seem overly simplistic, but that’s the way the court analyzed it.

There’s no surprise here. For other cases reaching the same result, see U.S. ex rel. Adams v. Wells Fargo Bank Nat. Ass’n, 2013 WL 6506732 (D. Nev. 2013) (in light of the GSEs’ lack of federal instrumentality status while in conservatorship, homeowners who failed to pay association dues to the GSEs could not be charged with violating the federal False Claims Act); Herron v. Fannie Mae, 857 F. Supp. 2d 87 (D.D.C. 2012) (Fannie Mae, while in conservatorship, is not a federal agency for purposes of a wrongful discharge claim); In re Kapla, 485 B.R. 136 (Bankr. E.D. Mich. 2012), aff’d, 2014 WL 346019 (E.D. Mich. 2014) (Fannie Mae, while in conservatorship, is not a “governmental actor” subject to Due Process Clause for purposes of foreclosure); May v. Wells Fargo Bank, N.A., 2013 WL 3207511 (S.D. Tex. 2013) (same); In re Hermiz, 2013 WL 3353928 (E.D. Mich. 2013) (same, Freddie Mac).

There’s a potential issue that the court didn’t ever reach. Assume that a purely federal agency holds a mortgage, and transfers it to its servicer (a private entity) to foreclose. Does Due Process apply? The agency is still calling the shots, but the private servicer is the party whose name is on the foreclosure. Don’t you think that’s an interesting question?

The borrowers’ second defense was that Michigan statutes require a recorded chain of mortgage assignments in order to foreclose nonjudicially. See Mich. Comp. L. 600.3204(3). In this case the mortgage had been held by ABN-AMRO, which had been merged with CMI (CitiMortgage), the foreclosing entity. No assignment of the mortgage had been recorded in connection with the merger. However, the court was not impressed with this argument either. It noted that the Michigan Supreme Court in Kim v JP Morgan Chase Bank, NA, 493 Mich 98, 115-116; 825 NW2d 329 (2012), had stated

to set aside the foreclosure sale, plaintiffs must show that they were prejudiced by defendant’s failure to comply with MCL 600.3204. To demonstrate such prejudice, they must show they would have been in a better position to preserve their interest in the property absent defendant’s noncompliance with the statute.

The court found that the borrowers were not prejudiced by the failure to record an assignment in connection with the corporate merger, and hence could not set the sale aside.

But this holding raises an interesting issue: When is failure to record a mortgage assignment ever prejudicial to the borrower? One can conceive of such a case, but it’s pretty improbable. Suppose the borrowers want to seek a loan modification, and to do so, check the public records in Michigan to find out to whom their loan has been assigned. However, no assignment is recorded, and when they check with the originating lender, they are stonewalled. Are they prejudiced?

Well, not if it’s a MERS loan, since they can quickly find out who holds the loan by querying the MERS web site. (True, the MERS records might possibly be wrong, but they’re correct in the vast majority of cases.) And then there’s the fact that federal law requires written, mailed notification to the borrowers of both any change in servicing and any sale of the loan itself. If they received these notices (which are mandatory), there’s no prejudice to them in not being able to find the same information in the county real estate records.

So one can postulate a case in which failure to record an assignment is prejudicial to the borrowers, but it’s extremely improbable. The truth is that checking the public records is a terrible way to find out who holds your loan. Moreover, Michigan requires recording of assignments only for a nonjudicial foreclosure; a person with the right to enforce the promissory note can foreclose the mortgage judicially whether there’s a chain of assignments or not.

All in all, the statutory requirement to record a chain of assignments is pretty meaningless to everybody involved – a fact that the Michigan courts recognize implicitly by their requirement that the borrower show prejudice in order to set a foreclosure sale aside on this ground.

NCUA Sues JP Morgan over MBS Representations

The National Credit Union Administration has sued J.P. Morgan Securities and Bear, Stearns & Co. for alleged securities laws violations relating to the sale of mortgage-backed securities to 4 credit unions that are now in NCUA conservatorship.  According to the complaint, Bear Stearns (now owned by JPMorgan) made misrepresentations to the purchasing credit unions as part of its underwriting and sales of the MBS.  The press release notes that NCUA has initiated eight similar suits against a variety of financial institutions.

One of the representations at issue states that “a mortgage loan will be considered to be originated in accordance with a given set of underwriting standards if, based on an overall qualitative evaluation, the loan is in substantial compliance with those underwriting standards.” (Complaint paragraph 408, page 170)

Given what we know about a lot of the securities that were issued, it is hard to imagine that reps like this were not violated for many of them.