Tag Archives: securitization

Ohio Court Grants in Part Securitization Sponsors’ Motions to Dismiss

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In Western & Southern Life Ins. Co. v. Residential Funding Co., No. A1105042, slip op. at 15 (Ohio Ct. Common Pleas June 6, 2012), an Ohio state trial court granted in part and denied in part motions to dismiss brought by defendants involved in the securitization and sale of mortgage backed securities. The court granted in part a motion to dismiss based on the statute of limitations and granted a motion to dismiss brought by officers of one of the defendant corporations on the ground that it lacked personal jurisdiction over those individuals. The rest of the motions were denied.

In connection with the purchase of $200 million of mortgage backed securities, plaintiffs Western & Southern Life Insurance Company, Western and Southern Life Assurance Company, Columbus Life Insurance Company, Integrity Life Insurance Company, National Integrity Life Insurance Company, and Fort Washington Investment Advisors brought an action alleging various kinds of fraud against defendants, a group of entities that participated in the securitization and sale of mortgage backed securities. The sponsors of the ten securitization actions in this case include Residential Funding Company, LLC, GMAC Mortgage, and Residential Accredit Loans. The underwriters included UBS Securities, RBS Securities, J.P. Morgan Securities, Deustche Bank, and Citigroup Global Markets.

Plaintiffs alleged that defendants’ fraudulent behavior included misrepresentation about owner occupancy rates, loan origination guidelines, appraisals and loan value ratios, underwriting guidelines, borrowers’ ability to pay, and transfer title issues. This case was before the court following oral argument on motions to dismiss plaintiff’s complaint on several grounds, defendants arguing (1) that the plaintiff’s claims are barred by the statute of limitations; (2) the plaintiffs failed to state a claim for which relief could be granted; (3) that plaintiffs failed to plead that the misrepresented or omitted matters were material; (4) that plaintiffs failed to properly plead reliance; (5) that plaintiffs failed to state the fraud and misrepresentation claims with sufficient particularity; (6) that plaintiffs failed to properly plead civil conspiracy; (7) that plaintiffs failed to adequately plead a claim for negligent misrepresentation; (8) that plaintiff National Integrity’s claims must be dismissed because its purchases occurred in New York, and (9) that the court lack personal jurisdiction over RFC Officers.

The Court granted in part and denied in part defendants’ motion to dismiss on the basis of the statute of limitations. The relevant statute provided that no action “shall be brought more than two years after the plaintiff knew, or had reasons to know, of the facts by reason of which the actions of the person or directors were unlawful, or more than five years from the date of such sale or contract for sale, whichever is shorter.” The court rejected defendants’ claims that plaintiffs had constructive notice more than two years before the complaint was filed because of rising delinquency rates and credit agency downgrades. The Court concluded that there was no “storm of warnings” sufficient to put plaintiffs on notice more than two years before the complaint was filed. However, the court granted defendants’ motion for all of plaintiffs’ claims within the 5 year statute.

The Court denied defendants’ motion to dismiss for failure to state a claim, finding that plaintiffs had pled facts sufficient to state claims for misrepresentation of underwriting guidelines, transfers of title, appraisals and loan to value ratios, credit ratings, and owner occupancy data.

The Court denied defendants’ motions to dismiss for failure to plead materiality of misrepresented material, failure to plead reliance, failure to state fraud with particularity, failure to plead the elements of civil conspiracy, and failure to plead negligent misrepresentation. The Court found that plaintiffs had sufficiently pled all of these elements. The Court also denied defendants’ motion to dismiss National Integrity’s claims.

With regard to defendants’ jurisdictional claim, the court found that although Ohio’s long arm statute extended jurisdiction to the officer defendants, such jurisdiction would not meet the requirements of due process with regard to the RFC officers.

Asset Quality Misrepresentation in RMBS Market

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Piskorski, Seru & Witkin have posted Asset Quality Misrepresentation by Financial Intermediaries:  Evidence from RMBS Market, in which they “identify misrepresentations by comparing the characteristics of mortgages in the pool that were disclosed to the investors at the time of sale with actual characteristics of these loans at the same time and show that such misrepresentations constitute a significant proportion of the loans.” (2) In particular, they

identify two, relatively easy-to-quantify, dimensions of asset quality misrepresentation by intermediaries during the sale of mortgages. The first misrepresentation concerns loans that are reported as being collateralized by owner-occupied properties when in fact these properties were owned by borrowers with a different primary residence (e.g., a property acquired as an investment or as a second home). The second form of misrepresentation concerns loans that are reported as having no other lien when in fact the properties backing the first (senior) mortgage were also financed with a simultaneously originated closed-end second (junior) mortgage. (3)

The paper has some extraordinary findings:

  • there “are instances where, in the process of contractual disclosure by the sellers, buyers received false information on the characteristics of assets.” (2)
  • “loans with misrepresented borrower occupancy status have about a 9.4% higher likelihood of default (90 days past due on payments during the first two years since origination), compared with loans with similar characteristics and where the property was truthfully reported as being the primary residence of the borrower.” (3-4)
  • “loans with a misrepresented higher lien . . . have about a 10.1% higher likelihood of default . . ..” (4)
  • lenders were “aware of the presence of second liens, and hence their misreporting likely occurs later in the supply chain.” (5)

The conclude that these “results suggest that RMBS investors had to bear a higher risk than they might have perceived based on the contractual disclosure.” (4)

Federal Reserve Report on the 30 Year Fixed Rate Mortgage

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Fuster and Vickery have posted Securitization and the Fixed-Rate Mortgage, a FRB of NY Staff Report.  This paper brings some empirical research to the debate over the proper fate of the 30 year mortgage.  Commentators are sharply divided over whether the government must be intimately involved in the operations of the residential mortgage markets in order to keep the 30 year FRM available in the United States.   (Whether that is a worthy goal is another question entirely.)

Peter Wallison at the American Enterprise Institute has argued that the existence of 30 year FRMs in the jumbo market demonstrates that the government does not need to play an active role in the mortgage markets to ensure the availability of that mortgage product.  David Min, formerly of the Center for American Progress, has argued that the government must continue to play an active role in order to keep that product in the market.  My own position has been in the middle — the government can reduce its dominant role in the mortgage markets while retaining a role during financial crises.

Fuster and Vickery test whether securitization, by allowing interest rate and prepayment risk “to be pooled and diversified, increases the supply of FRMs relative to ARMs.”  (1)  They find that “lenders are averse to retaining exposure to the risks  associated with FRMs in portfolio. Securitization increases lenders’ willingness to originate FRMs by transferring these risks to a diverse international pool of MBS investors.” (2)  Unsurprisingly, they also find that “when private MBS markets are liquid and well functioning, as in the period before the onset of the financial crisis in mid-2007, private and government-backed securitization perform similarly in terms of supporting FRM supply. However, public credit guarantees may make securitization less susceptible to market disruptions, thereby improving the stability of FRM supply.” (2)  Fuster and Vickery suggest that the current GSE- centered mortgage finance system may not be necessary for FRMs to remain widely available at competitive rates, but only as long as private securitization markets are liquid.”  (30)

Fuster and Vickery do not mean to say that they have produced the last word on this topic, but their findings are intuitive to me.  This debate is central to any plan for the future of the American housing finance system, so more empirical work in this area is most welcome.